Reason Foundation

The Concise Case for a Consumption Tax

John Tamny’s RealClearMarkets column yesterday looked at questions regarding the American tax code, the reasons for our high deficit, and the nature of the income tax. He concludes:

But as history has revealed in ugly fashion, politicians have very little discipline when it comes to spending, and the extra revenues have largely been used to expand existing government programs, or fund new ones. As for the deficits themselves, they've arguably been the result of investor belief that politicians are at the very least good at raising revenues from the productive class, thus making our deficits a good bet if markets are to be believed.

In that case it's time to look for modes of taxation most stimulative to economic effort, but that don't stimulate government growth through heavy revenue collection. A consumption tax would remove the existing penalty on work, would encourage savings and investment, but at the same time would make taxation a voluntary event, thus limiting not just government revenues, but also the government's ability to deficit spend given the limits imposed.

What would this shift provide as benefit? Earlier in the piece Tamny lays out a concise case for a consumption tax:

One form of taxation that has not been tried in modern times is a national consumption tax. The first glance advantages are of course positive.

For one, an income tax is a price placed on productive work effort. Worse, considering what monumental wealth generators Americans tend to be, such a tax is a grand source of revenue that allows our government to harshly expand its footprint on our economy.

And then not discussed enough is how successful it is at securing revenues from the "vital few", or the greatest wealth producers with the most productivity to tax. Supply-siders often brag about how much our tax code at present takes from the top 1 percent (at present the number is around 40 percent of total federal income tax revenues), but this isn't something we should be proud of.

Not asked enough is why the rich owe so much more than everyone else. Instead, it should be said that by virtue of growing wealthy the rich have conferred myriad benefits on society through lifestyle enhancing innovations and jobs, so to then hit them with a major portion of the tax bill seems backwards.

Better it would be to let taxation on the national level be voluntary. The more one consumes, the more one pays.

Such a tax would firstly support the most economically beneficial act of all which is to encourage saving. It is through savings that we expand the capital base necessary so that good ideas can be matched with investment, and a consumption tax would aid just that.

Second, a consumption tax would be the one way that the citizenry could limit the ability of the federal government to collect revenues. If in place, it's not unfair to assume that Treasury's ability to sell bonds necessary to fund a government that always seems to grow would be reduced. If so, as in if Treasury debt is made less attractive to investors, credit would migrate elsewhere; logically toward economic concepts that tend toward wealth creation rather than capital destruction.

Third, assuming an economic downturn, downturns regularly coinciding with reduced consumption, the federal government would be forced to get by on a smaller budget alongside Americans similarly making do with less. This alone speaks to recessions shorter in duration.

Indeed, as past columns have revealed about the 1920-21 US recession, it was then that government spending was cut in half in response to the economy's recessed condition. Of course with funds left in the private sector as a result, the subsequent rebound was rather powerful, and with a consumption tax we could perhaps count on something similar.